• Jeff Matthews

The New Risk Factor: Expletive Deleted

A new “risk factor” is cropping up in company conference calls: healthcare legislation.

Before the Securities Litigation Reform Act came along in 1995, companies could—and would—be sued for things that influenced their stock prices, even if those things were beyond management’s control.

Nowadays, so long as a company starts off its earnings call or conference appearance with a long-winded disclaimer of “risks and uncertainties”—to the effect that “Anything we say today might turn out wrong”—the company is somewhat safe from tort lawyers with nothing better to do than trolling for companies to drag down like wolf packs.

Usually, the “risks and uncertainties” covered by these disclaimers relate to demand, supply, pricing, margins, currency fluctuations, tax rates, inflation, earthquakes, patents, intellectual property and, of course, litigation from tort lawyers—among much else.

We are here to report that this “much else” now includes a new “risk factor,” healthcare legislation, as management of Dick’s Sporting Goods—a well-run retailer currently suffering at the hands of a retrenched consumer—highlighted on last week’s conference call:

We believe there is much uncertainty around the consumer’s attitude towards spending this holiday season, driven in part by the potential impact of healthcare legislation, possible new tax legislation, and the recently-announced 10.2% unemployment rate.

Dick’s management did not elucidate on the legislation coming out of Washington, but David Farr, the CEO of Emerson Electric Company, did, at a presentation on November 11 at an RW Baird Industrial Conference.

In fact, “elucidate” is too sedate a word for what Farr did: in fact, he unloaded.

Now, David Farr is not your normal grumpy CEO. He does not, for example, preside over a market-share-losing, money-losing, possible-NASDAQ-listing-losing enterprise like a certain irascible, finger-wagging, conspiracy-spewing CEO we could think of.

Nor has he done a discreditable job guiding his worldwide, industrial-sensitive enterprise through the financial crisis: indeed, despite a $4 billion sales drop (on a base of $24 billion), Emerson generated near-record cash flows in its just-ended fiscal year.

And since Emerson has its fingers in almost every aspect of the global economy, from chemicals to climate controls, attention ought to be paid.

Thus we thought it noteworthy to pass on Farr’s passionate, but informed, views on the current healthcare legislation and much else coming out of Washington, thanks to the indispensible StreetEvents. (Farr’s words in bold.)

“A Whole Different World”:

[This has been] a very drastic downturn. And the key issue is how fast is it going to recover? I’ll give you some ideas in a second on this. But I don’t think it’s going to be as fast as people believe. There’s a lot of stress in the world today. As I look at the Company and I look at the last two recessions, I just started my 10th year as CEO and I have had my second recession. It used to be ten-year cycles. We’re going to five-year cycles now, it looks like. And so if I look at the last downturn in ’01 and ’03, we took a 14% reduction in the headcount. We closed 75 facilities worldwide. We spent about $440 million restructuring, got the Company going and we grew quite rapidly.For five years, underlying growth rate of 8.5%, earnings growth close to 20%, certainly a lot of cash, the returns at an all-time high, close to 22% return on total capital for us at the endpoint. And then the shock came. I look at this cycle and what’s happening to us different than anything we have seen before. The world is definitely changing. You’re going to see a whole different world emerge in my opinion over the next five to 10 years as the mature markets — the US, Japan and Western Europe which are highly stressed, highly increasing debt levels and basically restricted of what they can do; if you don’t have a major play in the emerging markets, you will not see the type of growth that we have been seeing for the last four or five years.

“Definitely Getting Better”: We are dealing with a very difficult environment. It’s not going to change. It’s going to get a little bit better. But we are still dealing with a very weak global manufacturing industrial environment, though not as bad as it was two or three months ago as you’ll see. So as I look at that this right now, we’re looking at a very challenging year again; not as bad as last year. I mean, down 12% is the worst we have ever seen but it’s definitely getting better and you’ll start seeing this trend line coming. You will see that our orders will follow that very quickly…. “I’m Not Going to Hire Anybody in the United States” Now, to tell you how bad this is and tell you what I think Washington is doing right now, Washington is doing everything in their manpower capability to destroy US manufacturers, fundamentally destroy US manufacturers.Cap and trade, medical reform, labor rules, whatever they want to do, raise taxes. They’re just going to destroyed jobs. We have already reached 7.3 million jobs in this downturn. We’re going to 8. That is a summation of the last four downturns.So what do you think the recovery is going to be in jobs? It ain’t going to be very good. I listen to everything Washington is doing — wasting money, raising the deficit to 10, $12 trillion — the debt level to 10, $12 trillion, going to $23 trillion; raising taxes; putting regulations and requirements on me as a manufacturing company.What do you think I’m going to do? I’m not going to hire anybody in the United States. I’m moving. So they’re doing everything possible to destroy jobs, in my opinion. That’s my opinion as a manufacturer and we employ 125,000 people worldwide. So I do know what the (expletive) I’m talking about.We used to employ a lot more in the United States and we will continue to move [all this]. When I see guys like this, Wall Street bailouts, car bailouts, I’m looking — what are these guys doing with our money? They’re wasting trillions of dollars, trillions of dollars.So what they are going to do, they’re going to pass a new medical healthcare, raise my costs, jobs will go. Cap and trade, tax me, jobs will go. It’s pretty straightforward. What they’re doing right now ain’t working. 8 million jobs, summation of the last four downturns….

“Where the Opportunity Right Now Is” Why do you think we’re moving our companies into the emerging markets? Because that’s where the growth is. That’s where the jobs are going to be. That’s where we can create value. Share of this market is going to get less. It’s going to go down to 45%.So this is where we’re making our investments because this is where we are going to grow. This is what is going to happen in the economy. And so if you look at where the opportunity right now is, it’s not in Rhode Island. It’s not in Connecticut, it’s not in Illinois.It is in India, it’s in China. I’m taking another trip to China on Saturday. I go there seven, eight times a year. I go to Latin America, I go to the Middle East. That’s where the growth is going to be, international.Since I’ve been CEO, we’ve added close to 19 points of emerging market sales. We’re up to 33%…..

If you look at the last 10 years…73% of our growth has been in emerging markets. We have invested aggressively.

Where “The Degree of Freedom” Lies:

I lived over there, I ran Asia for a long time, for almost five years. I see the next five years an underlying growth rate of 5 to 7%. We’re going to have over 60% of our growth in emerging markets, maybe 70% again.The trend lines are there. Mature market growth will be a lot less just because the economics and the degree of freedom and the overcapacity issues we face in these countries.So we as a Company today are putting our best people, our best technology and our best investments in these marketplaces to grow. Because my job is to grow that top line, grow my earnings, grow my cash flow and grow my returns to the shareholders.My job is not to shrink and roll over for the US government. That is not my job. That’s not what I get paid to do. “Expletive Deleted”

You talk about in renewable and alternative, we have $50 million this year. We’re going to go to over $800 million in five years. We created wind converters for China. We have pitch controls, electronic controls for the windmills.At the bottom, we have solar products, both the systems and power conversion. So we have created a whole portfolio of products for this. But you’re not going to see Emerson going out there with fancy commercials or sitting at the right hand of some president talking about this (expletive). We do it. We (expletive) do it (expletive).I don’t need to be told, I don’t need to get government handouts, I can do it without them.

Before dismissing Farr as somewhat unhinged, recall that he employs 125,000 human beings and knows a thing or two about global competition—having lived in Asia himself, and more than doubling his company’s international business in ten years.Also, companies do not call out items as “risk factors” just for the heck of it: clearly Dick’s Sporting Goods sees a potential problem looming with its own customers.

And by way of coda, we’ll share a quote on the subject of healthcare reform from the calm, deliberate CEO of a small US-based company that manufacturers nearly all its product in China.

When asked if the recent drop in the US Dollar would hurt his price advantage versus US-sourced competitors, the CEO noted that, for one thing, dollar-priced raw materials consumed in China are paid for in a strong currency, keeping his cost of goods lower than for a US producer importing the same raw materials.

And for another thing, he added matter-of-factly, “When this healthcare bill passes, nobody’s going to want to manufacture in the U.S. anyway.”

Expletive deleted, indeed.

Jeff Matthews I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

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The content contained in this blog represents only the opinions of Mr. Matthews. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. The content herein is intended solely for the entertainment of the reader, and the author.

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